Wannabe Homebuyers Get No Encouragement From Fed: Caroline Baum

Like most observers of the business cycle, I have been
thinking a lot about housing, the small sector of the U.S.
economy with the big footprint. Housing started the ball rolling
-- both uphill and down, you might say -- and because of the
overwhelming number of bad loans, underwater mortgages and
foreclosed properties, it still can’t get up off the ground.

Specifically, I’ve been wondering to what extent the
presumed incentives for buying a home -- super-low mortgage
rates and discounted prices, down by one-third nationwide from
their 2006 peak -- are being neutralized by the Federal
Reserve’s tell-it-all communications policy.

Here’s what I’m getting at. Let’s say you are fortunate
enough to have a good job and some savings. Let’s further
stipulate that you are currently a renter, so you are in a
position to purchase a home.

Everything you see and hear suggests house prices have
further to fall. At the same time, you hear talk that the Fed is
going to keep short-term interest rates low for at least two
more years, maybe longer, and is considering renewed purchases
of mortgage-backed securities to reduce mortgage rates even
further. At this point, you:

a) Scan the real-estate ads in the local paper but opt for
weekend football on TV rather than house hunting;

b) Run your real-estate agent ragged looking at dozens of
houses as you scope out neighborhoods and school districts;

c) Talk to your local banker about various mortgage options
and current rates;

d) Consult with your accountant to assess the viability of
a home purchase in light of your finances;

e) Put a deposit on the first house that meets your
specifications.

Our potential homebuyer is apt to do some variation of a),
b), c) or d) to familiarize himself with the local housing
market and evaluate his finances so that when the time is right,
he has the information and the confidence he needs to bid on a
house.

What he won’t do is rush to buy a home now: option e).
That’s just common sense or, to put it in terms the Fed
understands, an example of rational expectations: the idea that
people make economic decisions based on past experience and
expectations about the future. According to this theory,
outcomes do not differ systematically from expectations, which
is why the Fed seems to focus on inflation expectations at the
expense of actual changes in the prices of goods and services.

A home is the single biggest investment most of us will
make in our lifetimes. No one wants to buy any asset, especially
a house, if prices are expected to fall and mortgage rates
aren’t headed higher.

“There’s a lot more incentive to buy now if you think rates
are going up,” says Michael Carliner, an economic consultant
specializing in housing. “People aren’t going to respond to
lower rates unless they think there’s a payoff.”

Due Diligence

In the old days, potential buyers, not to mention lenders,
analyzed their cash flow to assess their ability to make monthly
payments of principal and interest. It wasn’t until home prices
started to appreciate 10 percent to 15 percent a year, as they
did from 2002 to 2006, that housing became a tradable commodity
(who can forget condoflip.com?) and a free lunch.

Was it rational for millions of people to take out loans
they couldn’t repay to buy homes they couldn’t afford? Only if
they believed past performance was a guarantee of future
success, as the investment disclaimer goes. Their decisions were
based on the premise, regularly touted by then-Fed Chairman Alan
Greenspan, that housing prices hadn’t declined nationwide since
the Great Depression.

Sure, there were regional housing busts, such as the one in
the oil patch in the mid-1980s. But housing was considered safe.
After all, a house is a home. You live in it; you don’t trade it
like a stock or a commodity.

In retrospect, the behavior was irrational. Potential
homebuyers were caught up in the same frenzy that, a decade
earlier, drove soccer moms to buy shares of Internet companies
that had no revenue, no prospect of a profit and a ridiculous
business model.

There is every reason to believe home prices will have to
fall further to allocate supply, including the “shadow
inventory” of foreclosed homes. In the third quarter, almost
28.6 percent of single-family homeowners owed more on their
mortgage than their home was worth, according to Zillow Inc., a
real-estate information service in Seattle.

Unless future mortgage-modification efforts are more
successful than previous ones, house prices will have to fall.
What rational homeowner will step up to prevent the decline when
the Fed is providing an open-ended guarantee of low interest
rates?

(Caroline Baum, author of “Just What I Said,” is a
Bloomberg News columnist. The opinions expressed are her own.)